Spot Gold up after Downgrade of Italy

Gold rose on Tuesday, after Standard and Poor's downgraded Italy's credit rating, adding to the strain on the debt-distressed euro zone, while uncertainty over the outcome of a key U.S. Federal Reserve meeting also helped buoy the market.

In the latest blow to the euro zone, S&P cut Italy's sovereign credit rating by one notch, saying its economic growth prospects were getting weaker and planned reforms by the government would not help much.

A measure of German analyst and investor sentiment fell to its lowest in nearly three years last month, adding to the pressure on policymakers to stem the crisis, while markets attached a growing chance to Greece defaulting on its debt obligations.

Gold shrugged off a rise in European stocks, which would normally reflect a pick-up in investor appetite for risk. But the rise on the stock market was led mostly by so-called defensive shares, which act almost as safe-havens.

Also, gold's usual inverse correlation with the European equity market has eroded over the last month, reaching its least negative since mid-August, which means it is more likely to move in tandem with stocks.

Spot gold in was last up by 0.9 percent at $1,793.90 an ounce by 0957 GMT, having fallen by nearly 1 percent so far this week, in its third consecutive weekly decline.

Increasingly over last couple of weeks, we've seen stories about how safe something is that is as volatile and that is doing a bit of damage here and has caused a few people to pull out and go on the sidelines, said Saxo Bank senior manager Ole Hansen.

The $1,765/70 area is reasonable support and that is giving a bit of confidence back to the buyers. But we really have been in a downtrend for the best part of the last couple of weeks and that needs to be broken ... and for that, we need to move back above back above $1,825, he said.

The volatility in gold prices in the past few weeks has indeed deterred some gold investors, as evidenced by the decline in speculative holdings of U.S. gold futures and a fall of nearly 2 million ounces in holdings of the metal in exchange-traded funds over the last month.

Bank of China , a big market-maker in China's onshore foreign exchange market, has stopped foreign exchange forwards and swaps trading with several European banks due to the unfolding debt crisis in Europe, causing some distress in market sentiment.

HOLDING STEADY

Gold is likely to hold steady over the coming day or so as investors await the outcome of the Fed's two-day policy meeting, at which the central bank is widely expected to signal what action it will take to encourage economic growth.

While markets are discounting a return to government bond purchases, the Fed has more tools at its disposal to boost consumer spending by keeping interest rates low, which create a supportive environment for gold, which carries no yield of its own and loses out to other dividend- or yield-bearing assets when rates rise.

Spot gold has lost more than 2 percent so far this month and 7 percent from the record high of above $1,920 hit on Sept. 6, but it is still up by more than a quarter from the end of 2010.

The high degree of uncertainty is expected to remain a major source of support for gold, according to participants at an industry gathering in Montreal this week.

Gold demand in China, the world's largest gold producer and second-biggest consumer, could rise 10 percent this year as consumers choose the metal as a form of wealth protection, the World Gold Council said on Monday.

In other precious metals, spot silver lost 0.8 percent to $39.38, but off the three-week low of $38.95 hit in the previous session.

Platinum rose by 0.3 percent to trade at $1,775.65 an ounce, while palladium rose 0.6 percent to $716.22.